Do Low Interest Rates Mean the Massive U.S. National Debt Doesn't Matter?
With U.S. interest rates plunging, some liberals are making the following argument: “Why worry about the exploding U.S. national debt? If markets aren’t worried, why should I be? Time for more stimullus.”
In fact, that seems to be just the argument that holds sway at the Obama White House. Except, of course, what we are seeing here is a flight to relative safety as the EU debt crisis continues to rage.
But that’s a mistake. As economists Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff warn in their new debt study, governments shouldn’t wait for financial markets to freak out before cutting debt:
We identify 26 episodes of public debt overhang–where debt to GDP ratios exceed 90% of GDP–since 1800. We find that in 23 of these 26 episodes, individual countries experienced lower growth than the average of other years. Across all 26 episodes, growth is lower by an average of 1.2%. If this effect sounds modest, consider that the average duration of debt overhang episodes was 23 years. In 11 of the 26 high debt overhang episodes, real interest rates were the same or lower than in other periods. …
Contrary to popular perception, we find that in 11 of the 26 debt overhang cases, real interest rates were either lower or about the same as during the lower debt/GDP years. Those waiting for financial markets to send the warning signal through higher interest rates that government policy will be detrimental to economic performance may be waiting a long time.”
This observation fits well with one now being made by Eurasia Group. As the consulting firm sees things, the U.S. will continue to be able to finance its deficit and debt cheaply in part because of continued global safe haven status. “But while this is a benefit, it also ‘curses’ the U.S. into a period of fiscal complacency.” As long as rates are low, there will be little pressure for a “grand bargain” to cut debt, according to the firm.
But as Reinhart, Reinhart, and Rogoff show, that approach may doom America to years or decades of subpar economic growth.